There's really very little incentive to invest your money or take up any financial instruments when you see your bank balance growing month on month. Why should you when you obviously spend less than you earn and you are feeling richer every year? It's probably also pretty evident you don't have much interest in learning how to invest your money or sacrificing your leisure time to identify a good financial consultant.
I mean, why bother going to so much trouble earning an extra $10,000 or $20,000 when it's going to simply sit in your savings and you aren't going to spend it anyway? It's better to simply be contented and not indulge in lifestyle inflation!
I get it.
It makes absolute sense as long as life remains status quo. In other words, you continue to receive your current remuneration and it potentially grows year on year to keep up with inflation.
I'm referring to you if you fall into the group whose lifestyle needs are pretty manageable. It might even be fulfilling because you have enough to own a car, your own home, catch up with friends at restaurants and go for that 1 to 2 overseas trips a year. On top of all that, you end the year with a nett surplus in their bank balance year on year. In fact, you may even enjoy priority status in 1 or more banks.
In this article, I challenge the assumption that purely relying on savings is practical and argue why you will eventually do something different about your situation.
Inflation & your psychological resilience is often underestimated
This is not meant to scare you. It's an observation I noticed from the current generation of retirees. How often do you find yourself complaining that the hawker raised prices again while you are working?
You might notice the change in prices but you just accept the fact that inflation exists. More often than not, it doesn't hinder you from buying your favourite hawker food or getting your coffee fix. Why? Because your income is comfortable and the price increments feels negligible. An extra 50 cents isn't going to be a deal breaker to eat your favourite food. Neither is a 1 dollar increase going to stop you from buying your favourite bubble tea.
Yet many retirees lament whenever NTUC increase prices or when the hawker food charges 50 cents more... don't get me started on transport costs and medical costs...
Technically, retirees should be more immune to price increases than us young people. They experienced inflation for more than 40 years of their lives. What's new? It's not like inflation is a modern day invention like NFTs or Bitcoins right?
When your income stops and your savings start to deplete you will start to feel insecure
The reality is, we don't know how long we will live. Statistics have shown people live longer. Just the Covid19 deaths reported daily seems to indicate there's a sizeable number of old people age 85 and beyond. This is only the people dying. What about the number of people age 85 and beyond who are still alive?
If you are reading this and you are in your 20s or 30s, don't be surprised if medical advancement plus our increased awareness on healthy living might make it a new normal for us to live till age 100.
The law of 72 states that 72 divided by the annual rate of return will give you the time required to double your money. Likewise, 72 divided by the annual rate of inflation will give you the time required to half your money. So 72 divided by 2.5% inflation rate would take you 28 years to half your spending power.
Everyone behaves nonchalant that they are mentally prepared to drawdown their savings during retirement. However, a person who only saves in the bank essentially would be drawing down on their savings with no inflow of funds besides CPF payouts. How would one feel when the savings drops till the mid point mark?
Seriously indifferent? It doesn't matter if you calculated you have enough to run down to zero. You don't know how long you will live! Mark my words, you will tighten your purse and try to cut expenses thereby compromising on your lifestyle. If you miscalculate inflation, you might freak out more if your savings drop too fast and you foresee yourself living for another 10-20 years.
It's already happening. Retirees are cutting expenses if they have no income or are taking up part time work to maintain an income.
You need an income to feel secure.
The truth is, the only reason why anyone would behave indifferently during their working years and ignore retirement planning is because they can finance their existing lifestyles comfortably and have a growing bank balance.
It is thus logical to assume one can continue their blasé approach towards rising cost of living as long as they continue to have an income that beats inflation. Which means a bank savings account or anything which is safe and fully flexible is not suitable due to the low (or non-existent) rate of return.
Here are some instruments that provide an income that meets inflation (currently):
Bonds
Dividend generating investments
Rental income from property
Annuities
Retirement income from retirement plans
Alternative investments
These instruments have its own set of pros and cons each. The point is, your money can't sit in the bank and do nothing!
To put it bluntly, if your future retirement life isn't the same as your present life, you might experience psychological discomfort. Frankly, you might not even be able to accurately predict how you might behave when that time comes. We simply choose to be optimistic and not think about the problem. But do you seriously want to gamble your next 20 to 40 years on that assumption?
You might need time to get your income right
So if we established the need to maintain our income during retirement, then it is also natural to expect we need to use some form of financial instruments. Perhaps some might believe that with a huge warchest saved up at retirement, there will be abundant of options to choose from.
Which is fair. However, would you feel comfortable to put a significant portion of your savings into something untested at that point in time? For instance, if you are 25 years of age and need $2,500 in expenses today's value at age 65, you would need an income of $6,000/month. Assuming a 5%p.a. income return, this would amount to $1,500,000 invested into that instrument. Having worked in the bank and seen clients who are first time investors put significant lump sums into financial instruments out of blind faith, I'd say this behaviour is highly possible. But, is it prudent?
If you start financial planning early and take baby steps early, you give yourself room to make mistakes and learn from them. Sometimes, taking up certain instruments might not be a mistake (in terms of losses). You might learn that you aren't psychologically suitable for certain instruments because market volatility makes you unable to sleep. Then you know you need to commit more funds to safer instruments (lower returns too).
Don't put yourself into a situation where your decision making might be impaired
Also, certain safer instruments like endowments may take a few years before they can start paying an income to you. If you delay taking action till 65, you might find these instruments unattractive because you want immediate income. This might lead you to make riskier decisions like investing in stocks, buying high yield bonds or committing to an investment property with full cash. It's fine if you understand what you are getting into. Although many times, people just assume they do until something goes wrong...
However, most of the time, people who jump from no financial instrument to a higher risk one with a significant portion of their savings would find it to be an extremely scary experience. Often a misstep might be unimaginably expensive. Often the reluctance to make such a huge commitment at that point of time would result in people doing nothing and opting to cut expenses as much as possible. This means, you saved up all your money and you dare not spend it!
Summary
Hopefully this article brought out some points for consideration if you are holding too much cash presently. As much as financial planning may not be an activity that excites you, it's a fairly necessary activity. I hope this article also managed to illustrate why most of us will eventually realise our indifferent behaviours towards our financial wellness isn't sustainable. Since we would eventually do something about it, we are definitely better off starting early rather than late.
Read also: 5 retirement strategies common in Singapore
After reading this article, you might be keen to have a discussion to explore how to get started on retirement planning. You can reach me by dropping me a message.
Be sure to share the article if you feel this information is helpful. You will enable a lot more people to learn more about retirement planning.
About Janice I specialize in portfolio optimization (ensuring you get maximum value for every dollar you put in) and retirement planning. I am also building a team of financial advisors who are committed to help responsible individuals attain their goals without misallocating their resources. Do reach out if you would like to explore a career with me. Clients look for me primarily to outsource their retirement planning needs so that they can focus on other aspects of life that interests them. Many of whom are very good in earning their incomes in their respective professions and wish to ensure their monies continue to work harder while they focus on what they are good at. Refer to client testimonials here. I've helped many clients who are referred to me reduce the costs they are paying for their insurance or help provide solutions when they deem they are stuck with huge commitments bought when they were younger but unsuitable for their present life stages. You can reach me at 94313076 or my social media accounts on Facebook and Instagram. Disclaimer: The content created are based on my personal opinions and may not be representative to everyone or any organisation. If you have any doubts or queries pertaining to insurance or investment, please seek professional advice from a trusted adviser in an official setting. You may also reach out to me if you do not have a present adviser using the message box under 'Let's Talk'.
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